Bonds lose ground

JulieRannazzisi

NEW YORK (CBS.MW) -- Treasury issues backpedaled, and the 30-year briefly touched the psychologically-important 6 percent yield, ending just a whisper below the key level.

The bellwether last closed above a yield of 6 percent on May 11, 1998, when it stood at 6.038 percent.

"The [economic] fundamentals are the same at 6 percent [yield on the 30-year] than they are at 5.99 percent but it's a psychological level. It reminds people that rates are rising," remarked Hugh Johnson, chief investment strategist at First Albany.

A collapse in the dollar -- which brought in sellers of long-term Treasurys -- as well as hawkish comments from two Fed officials weighed heavily on a market that's obsessed by inflation fears. That's why the June 16 release of the consumer price index will be of paramount importance.

"The CPI will tell the tale on a Fed move," said Josh Feinman, chief economist at Deutsche Asset Management Americas.

Let's look at the possible scenarios. A 0.1 percent rise in the core CPI rate -- which excludes food & energy components -- would alleviate the market's fears and produce a rally, while a 0.3 percent rise would crush the market, Feinman said. Unfortunately, the most likely scenario is a rise of 0.2 percent -- which constitutes an inconclusive "gray area" and would leave questions regarding inflation unanswered, he added.

Mike Ryan, strategist at PaineWebber, said it's hard to tell when investors will see rates as attractive enough to spark buying. He thinks a yield of around 6 1/8 percent on the 30-year will find sponsors.

The benchmark 30-year bond fell 12/32 to yield
TYX, +2.24%
5.997 percent. The 10-year edged down 6/32 to yield
TNX, +3.23%
5.83 percent while the 5-year slipped 2/32 to yield 5.726 percent. The 2-year was off 1/32 to yield 5.553 percent. The discount rate on the 52-week bill was up 2 basis points at 4.83 percent. In the futures pit, the September T-bond was slid 15/32 to 115-19.

In the commodity arena, the Bridge/CRB index fell 0.67 to 192.46 while July crude fell 20 cents to $17.66. See latest commodity prices.

Fed talk generates worry

Recent comments from Fed officials have been consistently pointing out that inflation risks have increased.

"They're prepping the market for a rate hike," Ryan said.

St. Louis Fed President William Poole, a hawk and a non-voting member of the FOMC, said inflation risks are higher at present compared to just six months ago and that the current pace of U.S. economic growth isn't sustainable, which unnerved a market already suffering from intense jitters. And Richmond Fed President Alfred Broaddus, another Fed hawk and also a non-voter, said risks that the economy is overheating exist.

Alan Day, economist at the Stratevest Group, which manages over $4 billion in stocks and bonds, said Fed chief Alan Greenspan is very good at getting his message out early and preparing the market.

With all the necessary data in his hands, he'll have the possibility to send out clear signals to the market during his June 17 Congressional testimony before the Joint Economic Committee.

Feinman said there won't be any surprises for the market after June 17.

Tuesday's economic calendar saw the revision to first quarter non-farm productivity data. The figure was downwardly revised to show a growth rate of 3.5 percent from the previously reported 4 percent rise. Analysts polled by CBS MarketWatch.com had expected productivity to be revised to reveal a rise of 3.6 percent. The revision is a slight negative for the market as recent huge productivity gains have allowed the U.S. economy to grow without producing inflation.

The economic docket will be dry Wednesday, with no releases on tap. See , , and

Investors lose interest

Flows in the Treasury market remained on the light side for the brunt of the session as interest continued to wane.

Linda Henderson, senior vice president and director of retail fixed-income at Dain Rauscher Wessels, said these higher Treasury yields aren't luring investors into the market because they're worried that rates will go up further.

Thus, investors aren't nibbling, Henderson said, preferring to wait until they see the looming inflation reports before committing.

"It's not surprising that there aren't any flows out there," said John Spinello of Merrill Lynch. He said that Friday's PPI and retail sales figures are the only ones the market can trade on this week.

Meanwhile, the landscape has been chock-full of flows tied to corporate issuance -- which has put pressure on the 5- and 10-year sectors in particular -- as issuers sell Treasurys to protect themselves from interest rate fluctuations when pricing a deal.

Curve swings

The yield curve has been flattening dramatically as the market prepares for the very real possibility of a Fed tightening. Short-term issues, always the most sensitive to moves in the fed funds rate, have, in fact, been lagging their long-term counterparts.

But this trend was disrupted Tuesday afternoon, as sellers in the long end produced a steeper slope. The difference between the yield on the 30-year bond and 2-year note widened to 44.4 basis points from 42.4 basis points at the close Monday.

However, the flattening trend is likely to resume promptly, according to strategists, if strong inflation numbers convince the market that a Fed rate hike at the next June 29 and 30 Federal Open Market Committee meeting is a done deal.

A nudge up in rates -- which means the Fed is being vigilant on inflation -- would be met by a sigh of relief by riskier long-term issues, which would outperform on the curve.

Spinello believes the twos/bond spread has another 6 to 10 basis points of flattening left before reversing its path. In fact, curve traders are likely to take their profits and trigger some steepening once a Fed decision on interest rates hits the market.

Buck blues

The dollar suffered steep setbacks against the yen and the euro, extending earlier losses in afternoon trading.

The euro posted dramatic gains Tuesday after collapsing to new lows Monday as Germany's gross domestic product bested expectations. Europe's biggest economy grew 0.4 percent in the first quarter of 1999, and grew 0.7 percent year-on-year. Economists had expected 0.2 percent growth in the first quarter.

The euro is also benefiting from increased hopes that the Kosovo conflict will be settled. The young currency has gyrated back and forth in response to developments in Yugoslavia, but most of those moves have been short-lived in nature. The yen staged a remarkable recovery, meanwhile, after drooping earlier in the session on comments from Eisuke Sakakibara -- Japan's vice finance minister for international affairs who is often referred to as 'Mr. Yen' for his ability to influence currency markets. He said a sturdy yen is not desirable at this stage as it would hamper Japan's recovery. But the dollar's ebullience was short-lived indeed, and the unit slipped to an intra-day low of 118.75 after climbing as high as 121.66.

Jeffrey Yu, senior trader at Sanwa Bank, said once 120.50 was broken on dollar/yen, hedge funds began unloading dollars, exacerbating the plunge. These funds may have also been unloading Treasury issues.

Yu said he expects "verbal intervention" from Japanese officials once the Asian session begins to prevent the yen from getting too aggressive, as it would hurt exporters and corporations. What will be key for dollar/yen, he added, are the gross domestic product figures from Japan, to be released on Thursday.

In the meantime, Japan's Economic Planning Agency released its monthly report on the economy, indicating that the deterioration in Japan's economic conditions was coming to a halt. The EPA said the economy is close to bottoming, although a turnaround isn't to be expected immediately.

Separately, a survey released by the Ministry of Finance revealed that Japanese companies are less pessimistic regarding the economy, as evidenced by improvements in the business sentiment index for large companies to negative 9.9 in the April-to-June period from negative 17.9 in the previous period.

Dollar/yen was recently changing hands at 119.17, off a whopping 1.3 percent from Monday's close while the euro roared 1.7 percent higher to 1.0460 after reaching an all-time low of 1.0260 on Monday. View latest currency rates.

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